Finance 8. Oversimplification tendency ink of this as “common sense bias”: the strong belief that there is a clear, simple, straightforward, “common sense” explanation and solution to pretty much any problem or challenge which we might be facing. is tendency can sometimes lead to oversimpli cation of complex and/or uncertain nancial decisions. Instead of trying to understand the di erent aspects and nuances of a given investment, or formulating several possible strategies for a given nancial planning goal, our minds push us to view the challenge in clear-cut, black-andwhite terms, andmove toward an easy solution. Sure, sometimes such a move pays o . Many times, it doesn’t. How to protect yourself − recognize that some nancial challenges are inherently complex or uncertain − this is especially true if the challenge at hand is analyzing a potential investment. In such cases, it’s important not to “force” a common sense solution; this can lead to errors and oversights as we overlook factors that can a ect the outcome of our decision, instead of taking the time to do the long, hard process of reasoned analysis. 7. Mental accounting Imagine you just received a $100,000 inheritance from your late Aunt Gladys. You know she would have preferred that you use your inheritance to invest, rather than just spending it. And so you go into the bank and purchase a GIC that earns you 2.2% annually. Meanwhile, you have a credit card balance of about $18,000 charging you 19.5% interest a year… at’s mental accounting: the tendency to view various sources or “pots” of money as inherently di erent from others. And it can lead to some pretty silly nancial decisions – you know exactly what we’re talking about if you’ve ever had second thoughts about paying for an expensive pair of shoes with cash, but have no problem paying for them with your credit card. Mental accounting happens because of the emotions which we sometimes attach to certain assets – a block of stock from a company we worked for; a savings bond that our grandpa purchased for us long ago; the house we grew up in, etc. From a strictly nancial perspective, such emotions are completely irrational –money is money, no matter where it comes from, and we should put it to its most valuable use, rather than letting emotions dictate what we do with it. How to protect yourself – Learn to see money as fungible: equal and identical regardless of where it comes from. Base your nancial decisions on the math: which course of action o ers the better rate of return, rather than the emotions which surround the decision. CSANews | FALL 2019 | 35
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